Thursday, May 26, 2011

Dominican Daydream

Rashi, our Australian Shepherd, followed me dutifully in to the kitchen, looking up expectantly as I opened my laptop to check the scores before we went out. The Red Sox had clobbered Cleveland. The Phillies, after Halladay gave up a 3-1 lead, were in extra innings with Cincinnati. Each team had just scored in the 10th to leave the scored tied at 4-4.

That is when Rashi's long night started. That is when Wilson Valdez earned himself a permanent place in Phillies, and baseball, lore. Perhaps it is too soon to speak the name Dave Roberts--the journeyman outfielder whose stolen base in the bottom of the ninth inning of an elimination game launched the Red Sox to the championship in 2004--but Wednesday night's game was the stuff kid's dreams are made of.

The game wore on. Inning after inning, the late relievers for each side handled their opponents with little threat of a resolution to the contest. By the end of the 18th inning, the Phillies last pitcher, Dennys Baez was spent, and there was no one left in the bullpen.

Enter Wilson Valdez. A 33-year old utility infielder from the Dominican Republic, Valdez had never pitched an inning as a professional baseball player. Not in the major leagues. Not in the minor leagues. But he was game to give it a shot, and Phillies manager Charlie Manuel had nowhere else to go.

Valdez proceeded to live a dream. The game was six hours hold, but the Philly faithful were hanging in. Fans--including many who clearly were going to be tired in school the next day--chanted his name as he faced the heart of the Reds line up.

And he looked the part. He looked like an infielder who had been handed the ball. One of his first pitches went wide to the backstop--he was not crisp. But he settled in, and one could slowly see the kid emerge, as the fantasy that happened to be real unfolded. He became the Dominican youth channelling Pedro Martinez, the Dominican legend who himself spent a few fading months in a Phillies uniform. Wilson and Pedro. Similar slight build. Right handers.

OK. Maybe that is the end of the comparison. One a slam dunk Hall-of-Famer. One, not so much. But on Wednesday night--or make that Thursday morning--Wilson Valdez channelled Pedro in his imagination. He was dealing.

He had clearly practiced the moves. Standing on the mound, right foot on the rubber, peering in for the sign. Like he had done it a thousand times before--just not for real.

He was a bit shaky at first, facing reigning National League MVP Joey Votto. His first batter as a major league pitcher. But Valdez was inhaling the wonder of the moment. A few pitches in, he shakes off the sign from Dane Sardinha. Hard to imagine what he was shaking off, actually. The 86 mile an hour fastball or the 88 mile an hour fastball. Perhaps he was clearing his head, checking to see if he was really there.

No. He was shaking off Sardinha because that is what a kid does, living out that moment. Top of the 19th. Facing the heart of the order. It is a mind game, me vs. the batter... Votto, perhaps not quite believing the situation, flied out lazily to center.

Then Valdez faced Scott Rolen, stirring the fans into a greater pique of frenzy. Go Wilson Go!

Scott Rolen! The scriptwriter made a great choice. Rolen came up in the Phillies organization. A powerful third basemen, heir to the hot corner legacy of Michael Jack Schmidt. Heir now as well to the boos that rained down on Rolen, the player who abandoned the city and the team, back in the days before the parade.

Valdez, still fighting for control of his pitches, located a fastball on Rolen's shin, and located him on first base.

But then, Valdez settled in. The outcome was never in doubt. It never is in those situations. Who misses that shot at the buzzer when you are a kid?

Valdez showed no fear. He was facing the heart of the order. He gave in to his inner Pedro, ceded his Dominican soul to his childhood hero. He peered in to Jay Bruce. Bruce, the powerful slugger, leading the National League in home runs.

Really, could it get any better this? First, the league MVP goes down. Next, he hits Rolen. Now he is facing down Bruce?

So he drops down, wheels in from the side. Pure Pedro. His teammates are in awe.

He is feeling it. He is dealing. Bruce takes him deep, but not deep enough. Flies out the the warning track in deep center.

Then with two outs, it comes down to Carlos Fisher. Relief pitcher. An easy out for any pitcher in the majors.

If he was facing a just any major league pitcher.

But he was facing Pedro Martinez.

It was over. As Fisher skied a pop up behind second base, Valdez was already trotting off the field as the ball landed in Placido Polanco's glove. It doesn't get any better than this.

If you weren't watching, it all ended in the bottom of the 19th. Phillies scored, and won 5-4.

The long night ended. Finally, Rashi got her walk. And Wilson Valdez became the first player since Babe Ruth to start a game in the field and win it on the mound.

Wednesday, May 18, 2011

Coming to grips with the price of oil.

The announcer on the radio gave the news: Oil prices fell back below $100, as the dollar strengthened….

That the price of oil would be a newsworthy event was not new. Since the OPEC oil embargo and gas lines of the 1970s, periodic high oil prices have made news, as they crimped the American pocketbook, and caused cascading political consequences.

Last week, faced with the economic and political consequences of high gas prices, President Obama sidled up to the Drill, Baby, Drill camp and offered his support to measures to support domestic oil production. Increased domestic oil exploration and production is probably a good idea. After all, the U.S. is the largest consumer of oil, and both our national security and economic security would be enhanced by reduced dependency on oil imports.

This, of course, has been the bi-partisan stance of presidential administrations dating back at least to the Nixon administration. And in terms of environmental impact, opposing oil production in the United States is not necessarily a laudable stance—if one's concern is about global environmental impact—as production in Nigeria, for example, is certainly subject to lower environmental standards than would apply in South Dakota or Alaska.

But the President's call for increased domestic production and exploration did not reflect new insights on U.S. energy policy or how oil dependency affects our foreign policy and military engagement. The President, of course, was responding to the price of gasoline at the pump.

This is a cyclical political script dating back forty years, which is pulled out of the can when gas prices rise. We need more production. We need more conservation. We need alternative sources of supply. Wind. Solar. Tar sands. Horizontal drilling. Hydraulic fracturing. The stuff we learn in those moments of pump price political pandering.

The issue reached an extreme during the 2007-08 presidential primary season when oil prices surged upward. The candidates and political parties fulminated in high lather about cause and effect, supply and demand, and ultimately who was to blame for our pain. As Goldman Sachs predicted $200 oil, candidates vacillated between calls to eliminate the gas tax, to tax the speculators driving up the price or to drill, baby, drill.

Then the price collapsed.

Months before the economy came unglued in the fall of 2008, crude oil prices came back to earth. After peaking over $145 around July 4th, the price was back below $100 by Labor Day, and continued down. All the talk of drilling and T. Boone Pickens wind farms died away. This time, the storm abated before any legislation could be passed, so there was no new ethanol fiasco. No new oil shale tax credits. No new market distorting initiatives put in place by lobbyists for one industry or another seeking an opportunity to benefit from the public’s fleeting attention.

Months later, the Commodity Futures Trading Commission settled the question of whether the price spike was driven by real or speculative demand. Outside of the public view, and far from the political limelight, the CFTC concluded that speculation was indeed the major factor in the price spike, as distinct from "natural" forces of supply and demand driven by economic growth and declining reserves.

That is to say, demand for the consumption of oil was not the driver, but instead it was demand for oil contracts as a financial instrument.

This conclusion is a salient one for our nation's energy policy, and our monetary policy as well. It may seem to be a peculiar feature of the modern economy that commodity price speculation drives the welfare of families and individuals. But whether it is the American family planning a summer vacation or a fruit vendor far away in Tunisia, the prices of commodities traded in Chicago and other financial capitals do indeed touch daily life in the real world.

This is not news. And it is not a modern day phenomenon, as commodity price speculation and hoarding have afflicted daily life throughout history, and Tunisia’s was not the first government to fall due to high food prices. Just ask Marie Antoinette. What is notably today is the direct linkage between currency trading and commodity markets.

Oil prices fell back below $100, as the dollar strengthened….

As illustrated in the graph below, oil today has become the new asset class for hedging against dollar risk in global trading. Today, the U.S. dollar stands alone as the reserve currency of the world economy—the currency that nations use for investing their own reserves and for denominating commodity and other transactions. Despite efforts—such as the creation of the euro—to supplant the dominance of the dollar, no alternative has emerged. The structural flaws of the euro were exposed in the 2008 collapse, as the U.S. Federal Reserve emerged as the sole backstop for the global financial system. Japan’s economy remains weak and threatened by an aging population. The renminbi will not be a real currency for global trading purposes until China is willing to relinquish its managed peg and expose its economy to real market forces.


As shown here, oil has become a nearly perfect hedge against fluctuations in the dollar. The peak price of oil—the red dashed line—in the summer of 2008 came just after the low point of the dollar that same year. The ensuing collapse in oil prices mirrored the rise in the dollar through the early months of the financial collapse. Then the price of oil moved upward—mirroring the rally in gold—as the dollar value declined once again in the wake of Federal Reserve policy driving liquidity into the banking system and the dollar downward through early this year.

Then finally, as announced on the radio, the dollar is now rallying in anticipation of the end of QE2, and the oil price rise has abated.

The linkage between monetary policy and oil prices raises questions for how a consistent domestic energy policy can be implemented if critical energy market price signals are distorted by linkages with monetary policy. Federal energy policies are presumably designed to spur investment into energy development—oil, gas and alternatives—but the such investments rely on the reliability of market pricing as an indicator of supply and demand equilibrium. If oil pricing increasingly reflects non-supply and demand factors, and is in part influenced by Federal Reserve policies and actions, there are significant ramifications for our energy policies.

In simple terms, if the role of oil as an asset class can be expected to significantly affect the price of oil and add to price volatility over time, investors in energy industries will have to consider that volatility and those characteristics as much as actual supply and demand for energy as they consider investment decisions.

The impact of the evolution of oil from a physical to a financial commodity is far reaching, as the decline in the value of the dollar and the correlated rise in oil pricing has most adversely impacted those nations whose currency is tied to the dollar.

China is grappling with that challenge now. By adhering to a dollar peg and declining to float the renminbi, China has been forced to accept the inflationary consequences of growing energy costs. As illustrated here, cost escalation in the price of oil has been most significant for those whose currency is tied closest to the dollar. Accordingly, India and China saw major spikes in oil prices in their respective local currencies, both in 2008 and this year, as compared the modest impacts in the Euro, and negligible impacts in the Australian dollar.


It may be that with the end of QE2, the dollar will stabilize, and with it the rhetorical drumbeat for new energy policies will subside. But the lesson should be internalized into our national debate over debt and deficits, as this same oil price shock that emerged from deliberate Fed policy to depress the value of the dollar will be visited upon us with greater ferocity should global bond markets finally give up on our ability to put our fiscal house in order, and leave us with a decline in the value of the currency—and accelerating energy costs— that is out of our control.

Tuesday, May 17, 2011

Thoughts on NYT and Goldman.

The New York Times today continued the glorification of Goldman Sachs. The article trumpeted the careers of the best and the brightest luminaries that have led Goldman in its transition from a partnership to public firm.

What is lost in this presentation of Goldman as the successful center of the world of finance is how that success has morphed. The financial meltdown caused aggregate losses to financial institutions that have yet to be tallied, though the numbers $2 to $4 trillion are bandied about. Goldman, much as their PR efforts have denied it, would itself have collapsed in the absence of the bailout of AIG counterparties and conversion to a Fed-eligible bank holding company. Why on earth Goldman fit the profile of "systemically important"warranting extreme public actions to assure its continued lifeis one thing, but to continue on with the hubris and arrogance, and ignore the fact that financial institution losses not only took down the world as we knew it, but also wiped out a century of earnings.

In the old days of Wall Street partnerships, these losses would have wiped out the Street, and the partners would have lost much—if not all—of their personal wealth. That is why it would have been unlikely to happen. Back in the day, each of those partners had the others looking over their shoulders, scrutinizing their business, their trades and their risk. It was a real market system, and the feedback was exacting. Partnership risks were assessed by those best able to understand them—unlike the well-documented, feeble efforts of under-staffed, and intellectually less capable regulators—and unreasonable risks and trades were taken off the table by those who had their own wealth at risk.

So tell me again how this works today? Heads we win, tails you lose? We are the best and the brightest when the bets turn our way, and you hold us harmless when we are wrong. Good deal for them. Bad deal for us.

Ah, what happened to the capitalism of my youth.

Wednesday, May 11, 2011

Same old, same old.

So John Boehner wants trillions of dollars in cuts. Trillions. And everything is on the table. Except tax increases. And except for allowing expiring tax cuts to expire.

But everything is not on the table if everything isn't on the table.

This, of course, is why the President should have embraced the recommendations of his debt commission that was released last December. Because Washington is unable to even pretend to have a real discussion about the fiscal direction of the country.

And the consequences of continuing down this path will be disastrous.

Just because U.S. treasuries are trading at their lowest levels in history should not be taken as much comfort. It just means that the end is not near. Yet.

If we get past May 21st—the beginning of the end of days according to some Biblical prophesiers—the next apocalypse on the horizon will be the one when the world finally decides that currency stability and fiscal self-discipline are necessary attributes of a nation hosting the global reserve currency. Somehow, a currency that offers a yield of below 1% in interest while declining in purchasing power by 20% does not serve the long-term interests of the global community.

For Boehner to even posture as part of the solution—and not even give a nod to the irony of the moment—is in itself frightening. It is one thing to appeal to your newest voting block by embracing anti-deficit rhetoric as part of the ongoing spectacle that has become our politics. And as long as that voting block is willing to buy the absurd notion that spending causes deficits but tax cuts don't, Boehner can keep riding that wave.

But if the issue is deficits and debt, then the measure of one's words must be in the outcome one produces. Yet Boehner stands before a crowd of bankers and traders and says with a straight face that he wants trillions in deficit reduction as the price of not accelerating the pace of the nation's march down the road toward judgement day.

Accelerating because he is not serious for one minute about tacking the problem. His goal, as the leader of his party in Congress, is the pursuit of power and majority status. That means winning middle class votes and upper class political contributions. And standing before that room of bankers and traders, he postured effectively to get the latter at the expense of the future dreams of the former.

He will get the political contributions not because anyone in that room buys the notion that this is about cutting deficits, but rather because everyone in that room stands to reap great benefit from keeping the Bush-era tax cuts in place, and putting off the day when we actually pay for what we budget at the federal level.

No. Boehner is not serious about achieving trillions of dollars in cuts. His is just a rhetorical flourish. And the proof is in the budget that the House has just embraced. Paul Ryan's budget plan, as economist Bruce Bartlett has pointed out, does nothing to tackle deficits, but instead produces deficits far larger than current Congressional Budget Office projections. Current budget policy produces $3.2 trillion of deficits through 2019, while the Ryan budget projects $4.3 trillion of deficits during that same timeframe.

Of course, one of the major differences is that the Ryan budget cuts taxes, but those tax cuts are not paid for even with the significant cuts in spending that are in that budget. Therefore, the debt ceiling argument that Boehner made this week—his appeal to step back from our bi-partisan march toward the next fiscal train wreck—is contradicted by his own budget: If Congress were to pass the Boehner-Ryan budget, the debt issuance through 2019 would project to be $1,000,000,000,000 higher than the path we are on now.

My only question is whether, as Speaker Boehner stood before that Wall Street crowd, he believed his own words. Does he believe that the House budget proposal fixed the problem—if the problem is debt and deficits? Does he believe that putting half of the budget on the table makes his words ring true? And which is worse, if he does believe or if he doesn't?

This is just the same old game. Listen to my words, write your check, give me your vote, but God forbid I should be held accountable for the results I produce. This is the rhetoric that has destroyed the Republican Party brand of my youth. Fiscal responsibility and intellectual integrity. Prudence at home and tempered humility abroad.

Those were the days.

Monday, May 09, 2011

Default is not in our future.

The notion of a default by the U.S. Government on outstanding Treasury securities is nonsense. This is not to say that Congress will act to raise the debt ceiling. Who knows what Congress, in its infinite wisdom, will do; but the notion that a failure to raise the debt ceiling will lead to a default by the U.S. Government on outstanding Treasury securities is nonsense.

Debt and deficits and default are thrown around loosely these days. Deficits are what we have when our budgeted revenues are less than our budgeted expenditures. Debt is what we issue from time to time to fund those deficits that result from our wanting more things from the government—services, wars, transfer payments—than we are willing to pay for in taxes.

And we also print currency.

Actually, printing currency is a concept that has largely been rendered quaint, but the concept of printing currency continues to hold a place in the public imagination for those times when the Federal Reserve funds some purchase or expenditure with money that it creates for that purpose, and is provided to the recipient through electronic transfer. There is no printing involved, and no currency either, at least in the Wikipedia definition of physical objects generally accepted as a medium of exchange.”

In the case of the current battles over the federal budget and the raising of the debt ceiling, increasing the debt ceiling may be necessary for the issuance of new Treasury securities—which once legally issued carry the full faith and credit of the United States of America—as presumably such bonds cannot be legally issued if the debt ceiling has been reached. Therefore, failure to raise the debt ceiling would presumably constrain the ability of the Federal government to “spend beyond its means,” meaning spending in excess of current revenues within a budget year. In the absence of debt capacity under the debt ceiling, federal spending would have to be held in check, and constrained to the amount of available revenues within a budget year.

But a failure to lift the debt ceiling should have no impact on the ability—and obligation—of the Fed to pay the interest and maturing principal owed on Treasury securities. Such payments will be paid by the Fed through an electronic transfer of funds that for all intents and purposes are created at the moment of transfer, without regard to any budgetary action by the Congress or the availability of revenues in the Treasury. No budgetary action or further appropriation is required for the simple reason that any Treasury debt currently outstanding was legally issued under the debt ceiling at the time it was issued, and the full faith and credit pledge of the Government is pledged to its repayment.

And this is true of the general obligation indebtedness of any state government as well. Or Greece, for that matter.

The difference of course is the printing press. California can default on its general obligation bonds—if its politicians continue to play the games that are becoming all too easy and routine—because it must have money in the bank to pay its bonds when they come due. There does not need to be an appropriation in the budget—though there always is—but there does need to be money in the bank. Because unlike the U.S. Government, California does not have the ability to create currency to pay the debts that it has legally incurred and to which it has pledged its full faith and credit.

But the U.S. Government does have that ability. And it does have that obligation. And the Fed would act on that obligation regardless of what games Congress and the President might continue to play—whatever posturing they might find to be in their partisan interests as this charade plays out.

The fact is that U.S. Government will not default on its duly and legally authorized Treasury securities. And anyone who is paying attention understands this. Like the bondholders. Today, the yield on three-month Treasury bonds was one basis point. That is one one-hundredth of one percent. Or 0.01%. This rate has not changed in the past month. The three year rate is still below 1.00%, and the benchmark 10-year rate is 3.15%, or more than forty basis points less than one month ago.

So Democrats and Republicans can yell about debt and deficits, and manipulate as much as they like the simple fact that for decades now none of them have cared one whit about it, except for those moments that come along when it serves some partisan interest, and they can whip voters—who should be ashamed of themselves for going along with all of this—into a frenzy. But the markets have not blinked.

Because for all the debt, and for all the deficits, a default is not in our future. Because we own the printing press.

Whatever that means.